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Onwards and Upwards
New York: May 11, 2009
By John Stephenson

It's hard not to get a little giddy, thinking about the stock market these days. Wasn't it just a couple of months ago when the end of the world seemed near? Even though the U.S. unemployment number keeps chugging higher and the nation's banks seem to need continual infusions of fresh government cash, we have a full blown rally on our hands. The only question on investor's minds these days is—can it last?

While it's clear that the nation's banks won't be allowed to fail, that doesn't mean that they will start lending any time soon either. Their near death experience and legitimate concerns over the deteriorating health of corporate and consumer credit has them staying close to shore. And that means it is unlikely that the U.S. consumer is going to come roaring back to the mall any time soon. Not to mention the fact that the average American consumer has looked on in horror as the auto industry, part of the fabric of American life, has shrunk before their very eyes. Most consumers know that the world they grew up in no longer exists, and they will think twice before they shoot the locks off their wallets.

But in spite of this seemingly bad news, the stock market has moved higher lately, in part driven by the stocks of commodity producers. Speculators have rushed into commodities as a way to play an emerging inflation theme, as the fret that the American government will prime the economy too much by injecting too much cash into it. And all that cash will be spent, sending prices higher.

Commodities have also been rallying lately, because there are signs that global industrial production may be picking up. One indicator of rising levels of global industrial production is the Baltic Dry Index, a measure of what it costs to ship steel, coal and other dry bulk goods around the world. If shipping rates are starting to move higher, then demand for raw materials is moving higher—a good sign that the global economy is starting to recover.

And that's great news for the beaten-up resource sectors. With global industrial production starting to grow again, the fortunes of commodity producers are starting to look a little brighter.

Unfortunately, the prospects for the health of the overall economy are not nearly so clear. The ranks of the unemployed continue to increase and there is fresh evidence that the outlook for the financial sector will continue to be depressed. Banks and other financial institutions are likely to suffer from a wave of commercial real estate loan losses as falling rents and continuing high levels of unemployment negatively affect lenders.

As the ranks of the unemployed continue to swell, the commercial real estate vacancies begin to swell. As a general rule, every person laid off results in 180 square feet of vacant office commercial space.

According to some estimates, the falling values of commercial real estate could have a devastating toll on the balance sheets of already bruised financial companies in America . Morgan Stanley, who narrowly dodged a bullet last year, could see forty-five per cent of its commercial portfolio wiped out if the worst-case scenario were to play out. For GMAC, the situation is similar—almost one-third of its commercial portfolio could be toast if the commercial real estate market were to deteriorate.

If we are in a bull market, then we are in a very special kind of bull market. One similar to what we experienced during the 1970s, where commodity producers and some of the riskier industrial companies were on fire, while the rest of the market was going nowhere.

It is clear, that the worst of the decline in the stock market is behind us, but in my view, it is too early for investors to jump in with both feet. The U.S. consumer is still not spending, and that will make whatever recovery there is, pretty tepid. If the economic turnaround is sluggish, then the stock market will likely be range bound for the foreseeable future. While the stocks of commodity producers are a good bet, most other sectors are better to take a pass, until the economy and the stock market look a little better.

StephensonFiles is a division of Stephenson & Company Inc. an investment research and asset management firm which publishes research reports and commentary from time to time on securities and trends in the marketplace. The opinions and information contained herein are based upon sources which we believe to be reliable, but Stephenson & Company makes no representation as to their timeliness, accuracy or completeness. Mr. Stephenson writes a regular commentary on the markets and individual securities and the opinions expressed in this commentary are his own. This report is not an offer to sell or a solicitation of an offer to buy any security. Nothing in this article constitutes individual investment, legal or tax advice. Investments involve risk and an investor may incur profits and losses. We, our affiliates, and any officer, director or stockholder or any member of their families may have a position in and may from time to time purchase or sell any securities discussed in our articles. At the time of writing this article, Mr. Stephenson may or may not have had an investment position in the securities mentioned in this article
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